Tax cut

A tax cut is typically seen as leading to a decrease in the amount of money taken from taxpayers, thus increasing the disposable income of taxpayers but decreasing government revenue. It usually refers to reductions in the percentage of tax paid on income, goods and services.
Tax cuts also include reduction in tax in other ways, such as tax credits, deductions, and loopholes.
As they leave consumers with more disposable income, tax cuts are an example of an expansionary fiscal policy.
How a tax cut affects the economy depends on which tax is cut. Policies that increase disposable income for lower- and middle-income households are more likely to increase overall consumption and "hence stimulate the economy". Tax cuts in isolation boost the economy because they increase government borrowing. However, they are often accompanied by spending cuts or changes in monetary policy that can offset their stimulative effects.
Sometimes a tax cut can increase tax revenue, as economist Thomas Sowell explains:

Types

Tax cuts are typically cuts in the tax rate. However, other tax changes that reduce the amount of tax can be seen as tax cuts. These include deductions, credits, exemptions, and adjustments. Additionally, adjusting tax brackets may indirectly reduce the amount of income that is subjected to higher tax rates.

Term	Definition	Example
Rate cut	A reduction in the fraction of the taxed item that is taken.	An income tax rate cut reduces the percentage of income that is paid in tax.
Deduction	A reduction in the amount of the taxed item that is subject to the tax.	An income tax deduction reduces that amount of taxable income.
Credit	A reduction in the amount of tax paid. Credits are usually fixed amounts.	A tuition tax credit reduces the amount of tax paid by the amount of the credit. Credits can be refundable, i.e., the credit is given to the taxpayer even when no actual taxes are paid.
Exemption	The exclusion of a specific item from taxation.	Food might be exempted from a sales tax.
Adjustment	A change in the amount of an item that is taxed based on an external factor.	An inflation adjustment reduces the amount of tax paid by the rate of inflation.

Effects

It has been argued that a tax cut generally represents a decrease in the amount of tax a taxpayer is obliged to pay, so that it results in an increase in disposable income. This greater income can then be used to purchase additional goods and services that otherwise would not have been possible.
Tax cuts result in workers being better off financially. With more money to spend a consumer spending increase would be expected.
Consumer spending is a large component of aggregate demand. This increase in aggregate demand can lead to an increase in economic growth, if other factors hold even. Thus, income tax cuts increase the after-tax rewards of working, saving, and investing, increasing work effort and contributing to economic growth.
If tax cuts are not financed by immediate spending cuts, there is a chance that they can lead to an increase in the national deficit, which can hinder economic growth in the long-term from increases in interest rates hindering investment. It also decreases national saving, and therefore decreases the national capital stock and income for future generations. For this reason, the structure of the tax cut and the way it is financed is crucial for achieving economic growth.

Supply-side tax cut

tax cuts are designed to stimulate capital formation by lowering the price level of a good and therefore increasing the demand for the good. Aggregate supply and aggregate demand will be shifted as a result.

Corporate income tax cut

tax cuts generate sustained effects on research and development expenditures, productivity, and output, therefore increasing GDP. To evaluate the impact of appointed tax policy, studying R&D expenditure and technological adoption are crucial.

Personal income tax cut

tax cuts only lead to a momentary boost to GDP and productivity, having no long-term effect on the GDP as they trigger extensive but short-lived response of capital expenditure, productivity and output. The key to evaluating the effect of personal income tax cut is the variable of labor utilization.

Value-added tax

is a general, broadly based consumption tax assessed on the value added to goods and services collected fractionally.
Cutting VAT can have significant repercussions on a country's economy. While it may stimulate short-term consumer spending and encourage business investment, there are trade-offs. Lower VAT rates reduce immediate government revenue, potentially impacting public services and infrastructure. However, if managed well, such cuts can contribute to long-term economic growth and fiscal stability. Policymakers must carefully balance the benefits of VAT reduction with the need for sustainable revenue collection.
One notable example of a focused VAT cut occurred in the UK during the pandemic. The standard rate of VAT dropped from 20% to 5%, specifically applying to the hospitality sector. This reduction aimed to support struggling businesses and boost consumer spending. However, it's essential to recognize that the main drawback of a VAT reduction lies in the fact that suppliers are not obligated to pass those savings directly to consumers. Therefore, while a VAT cut may create a small hole in overall VAT revenue, its impact on prices remains uncertain. EU regulations also allow for reduced VAT rates, but several countries have maintained VAT levels above the minimum thresholds.

Costs and Benefits Study

The working paper from 2017 for IMF posited three major factors regarding the effects of tax cuts:
1. The tax cuts can boost the economy in the short term; however, these effects are never strong enough to prevent loss of revenue.
Any tax cuts will significantly reduce tax revenues in the first place. The growing tax revenue from economic growth will never fully offset this fact. Thus, the gap needs to be compensated and financed by an increase in public debt, raising other taxes, or cutting spending. Usually, cuts in income tax are compensated by an increase in consumption taxes, but there are several ways a government may compensate for tax cuts:
a) By spending cuts
The final equity and change in aggregate demand will be equal to zero as some individuals will be better off from tax cuts while others will have to cut their spending as the government decreases welfare payments. At the end of the day, there is no change in overall welfare circulating in the economy.
b) By government borrowing
The government may compensate for the loss in revenue by borrowing money and issuing bonds. The overall result of this type of compensation may vary based on the situation of the economy. In a recession, borrowing would probably result in higher aggregate demand. In the boom, the borrowing may result in crowding out – a situation in which the private sector has fewer finances for their investments as they buy the bonds.
c) By cutting taxes in boom
Chancellor Nigel Lawson's tax cuts in 1988 occurred during a period of economic growth. These taxes led to a further increase in economic growth, however, also led to an increase of inflation causing a boom-and-bust cycle.
d) By improved productivity
If the tax cuts leads to a more productive economy, the tax revenue may counterintuitively stabilize following tax cuts, given that the economy grows in a stable manner for a few years.
2. The tax cuts may help low-income groups even if they do not get the tax cuts directly.
When the middle or upper class receives tax cuts, they often spend more money on the services which are provided by low-income individuals. On average, wealthier people tend to spend proportionally more of their income on services. With tax cuts, the expenditures of wealthier people increase together with the demand for services.
3. There is a tradeoff between growth and income inequality depending on what classes receive tax cuts.
Even though upper class tax cuts may increase demand for services from the lower class, income inequality and polarization tend to increase. Income tax credits for the lower class do not make as large of an impact on the income gap as tax cuts for the upper class. On the other hand, targeting the middle class with tax cuts reduces income inequality and polarization but may provide lower dividends from growth.

Countries

United States

Notable examples of tax cuts in the United States include:

The Tax Cuts and Jobs Act of 2017 lowered the corporate tax rate to 21%, while also lowering personal income tax rates, among other changes.
The 2008 American Recovery and Reinvestment Act included a tax credit of $400, lower payroll tax rates, and higher earned income tax credits.
The Economic Growth and Tax Relief Reconciliation Act of 2001 reduced business and investment taxes.

Tax policy varies from president to often propose tax changes, but Congress passes legislation that may or may not reflect those proposals.

John F. Kennedy

plan was to lower the top personal income tax rate from 91% to 65%, however, he was assassinated before implementing the change.

Lyndon B. Johnson

supported Kennedy's ideas and lowered the top personal income tax rate from 91% to 70%. He reduced the corporate tax rate from 52% to 48%. Federal tax revenue increased from $94 billion in 1961 to $153 billion in 1968.

Ronald Reagan

's policies included tax reforms. His administration implemented two significant tax acts. First, the Economic Recovery Tax Act of 1981 was implemented to stimulate economic growth, incentivize investment, and reduce the tax burden on individuals and businesses. Key provisions included lowering the highest personal income tax rate from 70% to 50%, and lowering the capital gains tax rate from 28% to 20%. The ERTA decreased federal revenue initially. Following the ERTA was the Tax Reform Act of 1986. The TRA built upon the ERTA, further reshaping the tax code with tax cuts. The highest personal income tax rate was reduced to 38.5% initially and eventually to 28%. The corporate tax rate also decreased, benefiting businesses. In 1988, Reagan cut the corporate tax rate from 48% to 34%. The TRA simplified the tax structure by reducing the number of brackets. While the TRA aimed for efficiency and fairness, it did not fully offset the revenue losses from previous tax cuts.
The 1980s witnessed economic expansion, often referred to as the "Reagan boom". In 1983, 1984, and 1985, the GDP grew by 4.6, 7.2, and 4.2% respectively.
While the tax cuts contributed to this growth, other factors, such as Federal Reserve actions, increased federal spending, and business investment, also played roles. The tax cuts worsened budget deficits in the short term, but the economic expansion eventually led to lower deficits. After peaking in 1986, the federal deficit gradually declined by 1989.